Should Clients Cover Their Own Negative Balance?

This article is written by Ron De Luca who is a senior risk analyst at Mercer Capital Ltd., a NZ regulated forex brokerage.

Since the Swiss Franc crisis shook the global currency market, many brokers either became insolvent (Alpari) or are well on their way to becoming insolvent (FXCM). There is now a debate amongst brokers about whether or not traders should be responsible for negative account balances. This article will address why I believe the traders should never be responsible for Negative Balance Negative Balance In its most basic form, a negative balance represents an account balance in which debits exceed credits. A negative balance indicates that the account holder owes money. A negative balance on a loan indicates that the loan has not been repaid in full, while a negative bank balance indicates that the account holder has overspent.In the retail brokerage space, this phenomenon occurs when a position’s losses in an account exceeds the available margin on hand from a given trader. When a trader places a trade that sharply goes against the chosen direction, an account can incur negative balance. Such exposure is traditionally very risky for brokers. While the foreign exchange market is the most liquid market in the world, unexpected economic, geopolitical or cataclysmic events can always cause a market disruption and consequently lack of liquidity.This has occurred during certain events, albeit limited, which have resulted in extraordinarily sharp movements over short timeframes such as the Swiss National Banking Crisis in early 2015.Negative balances are addressed in many jurisdictions globally and clients in the EU are protected from such risks. As a consequence, brokers are the ones which are exposed to the risks associated with covering the negative balance with a prime broker or a prime of prime. New Negative Balance Protections Look to Shield Market ParticipantsAs a countermeasure to the risk associated with negative balances on a wider scale, many brokers now have since adopted negative balance protections. These mechanisms are an automated adjustment of the account balance to zero in case it became negative after a stop out.Traders operating with a broker that offers negative balance protection often cannot lose more than deposited as this shields both the trader and broker from wider losses in times of crisis. In its most basic form, a negative balance represents an account balance in which debits exceed credits. A negative balance indicates that the account holder owes money. A negative balance on a loan indicates that the loan has not been repaid in full, while a negative bank balance indicates that the account holder has overspent.In the retail brokerage space, this phenomenon occurs when a position’s losses in an account exceeds the available margin on hand from a given trader. When a trader places a trade that sharply goes against the chosen direction, an account can incur negative balance. Such exposure is traditionally very risky for brokers. While the foreign exchange market is the most liquid market in the world, unexpected economic, geopolitical or cataclysmic events can always cause a market disruption and consequently lack of liquidity.This has occurred during certain events, albeit limited, which have resulted in extraordinarily sharp movements over short timeframes such as the Swiss National Banking Crisis in early 2015.Negative balances are addressed in many jurisdictions globally and clients in the EU are protected from such risks. As a consequence, brokers are the ones which are exposed to the risks associated with covering the negative balance with a prime broker or a prime of prime. New Negative Balance Protections Look to Shield Market ParticipantsAs a countermeasure to the risk associated with negative balances on a wider scale, many brokers now have since adopted negative balance protections. These mechanisms are an automated adjustment of the account balance to zero in case it became negative after a stop out.Traders operating with a broker that offers negative balance protection often cannot lose more than deposited as this shields both the trader and broker from wider losses in times of crisis. Read this Term reimbursement.

One of the main causes of this issue are the risky margin call level settings that many reputable brokers offer to traders. These levels are typically below what should be considered safe from a proper Risk Management Risk Management One of the most common terms utilized by brokers, risk management refers to the practice of identifying potential risks in advance. Most commonly, this also involves the analysis of risk and the undertaking of precautionary steps to both mitigate and prevent for such risk.Such efforts are essential for brokers and venues in the finance industry, given the potential for fallout in the face of unforeseen events or crises. Given a more tightly regulated environment across nearly every asset class, most brokers employ a risk management department tasked with analyzing the data and flow of the broker to mitigate the firm’s exposure to financial markets moves. Why Risk Management is a Fixture Among BrokersTraditionally the company is employing a risk management team that is monitoring the exposure of the brokerage and the performance of select clients which it deems risky for the business. Common financial risks also come in the form of high inflation, volatility across capital markets, recession, bankruptcy, and others.As a countermeasure to these issues, brokers have looked to minimize and control the exposure of investment to such risks.In the modern hybrid mode of operation, brokers are sending out the flows from the most profitable clients to liquidity providers and internalize the flows from customers.This is deemed less risky and are likely to incur losses on their positions.This in turn allowing the broker to increase its revenue capture. Several software solutions exist to assist brokers to manage risk more efficiently and as of 2018, most connectivity/bridge providers are integrating a risk-management module into their offerings. This aspect of running a brokerage is also one of the most crucial ones when it comes to employing the right kind of talent. One of the most common terms utilized by brokers, risk management refers to the practice of identifying potential risks in advance. Most commonly, this also involves the analysis of risk and the undertaking of precautionary steps to both mitigate and prevent for such risk.Such efforts are essential for brokers and venues in the finance industry, given the potential for fallout in the face of unforeseen events or crises. Given a more tightly regulated environment across nearly every asset class, most brokers employ a risk management department tasked with analyzing the data and flow of the broker to mitigate the firm’s exposure to financial markets moves. Why Risk Management is a Fixture Among BrokersTraditionally the company is employing a risk management team that is monitoring the exposure of the brokerage and the performance of select clients which it deems risky for the business. Common financial risks also come in the form of high inflation, volatility across capital markets, recession, bankruptcy, and others.As a countermeasure to these issues, brokers have looked to minimize and control the exposure of investment to such risks.In the modern hybrid mode of operation, brokers are sending out the flows from the most profitable clients to liquidity providers and internalize the flows from customers.This is deemed less risky and are likely to incur losses on their positions.This in turn allowing the broker to increase its revenue capture. Several software solutions exist to assist brokers to manage risk more efficiently and as of 2018, most connectivity/bridge providers are integrating a risk-management module into their offerings. This aspect of running a brokerage is also one of the most crucial ones when it comes to employing the right kind of talent. Read this Term perspective. The reason is there are many scam brokers in the market offering too-good-to-be-true trading conditions. The reputable brokers then need to compete by offering unrealistic terms to new clients.

Because the brokers allow traders to use almost all of their equity before being stopped

out, there’s not enough padding at a margin call to properly exit a trade in extreme market movements. Therefore, the investor’s account hits a minus because there’s no one in the market to take the other side of the trade.

The question then arises: Should the client be responsible for the negative balance? The answer is simply "no" for the following reasons.

1. The client chose to invest a specific amount of money. When the investment was made, the investor did not request a loan from the broker in the case of the account going into negative. The investment is the maximum amount of money the trader is willing to lose.

2. Just as investors need to manage their own risk parameters when investing, so do forex brokers. They have full teams devoted to managing company risk. If the margin call settings are too risky, client accounts can dip into the negative.

It’s important to find a reputable broker with realistic trading terms. This allows the trader to have a fair opportunity to profit and the broker can minimize their risk.

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